Tax Yale's Endowment? Good Luck With That

Noah Feldman is a Bloomberg View columnist. He is a professor of constitutional and international law at Harvard University and was a clerk to U.S. Supreme Court Justice David Souter. His books include “Cool War: The Future of Global Competition” and “Divided by God: America’s Church-State Problem -- and What We Should Do About It.”Read More.

"It is, Sir, as I have said, a small college. And yet there are those who love it!" These words, spoken by Daniel Webster, are among the most famous ever uttered before the Supreme Court. And they may be spoken again if Connecticut passes proposed legislation that would tax Yale University’s $25.6 billion endowment.

Yale isn't especially small, nor is it vulnerable as Dartmouth was in 1818 when Webster spoke of his alma mater. But the Connecticut bill almost certainly violates the holding in the 1819 case of Dartmouth College v. Woodward, which established that the Constitution bars states from changing a university's charter.

Begin with the Connecticut bill, which points to the difficult question of whether it’s fair for some universities to be so much richer than others. I benefited in my education from the tremendous resources of well-off institutions like Harvard and Yale, and I’m writing this in my office at Harvard Law School. I’m hardly objective.

But I'll try to be fair. Yes, Yale’s wealth is mostly the product of voluntary, generous private donations and clever investment. Yes, unequal institutional resources are a mirror of broader inequality in our capitalist society. So why shouldn't nonprofit organizations like universities be subject to the same redistributive principles that we embrace when it comes to taxing the income of for-profit businesses?

The answer is that the proposed Connecticut bill would seem to violate Yale’s constitutional rights.

Yale’s charter dates to 1745, more than 30 years before Connecticut was a state. The colonial legislation creating the college specified that its property, and that of its employees, "shall be freed and Exempted from all Rates Taxes Military Service Working Service Working at High Ways & other such like Duties and Services."

It's worth noting that the charter didn't say that the exemption should be limitless. It specified that the exemption applied only to "Lands and Ratable Estate belonging to ye said College not Exceeding ye Yearly Vallue of five Hundred Pound Sterling." That was a lot of money in 1745, but it wasn’t anywhere near $25.6 billion.

In 1834, the Connecticut legislature affirmed the principle, specifying that any funds donated to the college "and by them invested and held for the use of that institution, shall with the interest thereof, be and remain exempt from taxation." Once again the legislature set a cap, stating that the tax exempt status only applies to property producing income of up to $6,000 annually.

An 1872 law removed the cap altogether, leaving all the college’s funds tax free. In 1882, the legislature tried to put back the $6,000 cap, but the Yale Corporation refused to accept the change to its charter, which would have been necessary to amend it.

In testifying before the Connecticut Senate last week, Richard Jacob, Yale’s associate vice president for federal and state relations, asserted that the bill would be unconstitutional under the Dartmouth College precedent. The university’s logic runs as follows:

In the Dartmouth case, the issue was whether the New Hampshire state legislature could appoint new trustees who would have put the institution under the governor's control. The court observed that the Dartmouth charter of 1769 had given the existing trustees, not the legislature, the power of appointing trustees.

The opinion, by Chief Justice John Marshall, acknowledged that the contracts clause of the Constitution was intended primarily to stop states from releasing private debtors from their obligations to creditors. Nevertheless Marshall held that the clause also prohibited the state from changing the charter because doing so would amount to "impairing the obligation of contracts." He wrote, "A grant of corporate powers … is as much a contract, as a grant of land.”

According to Yale, the principle applies directly to its situation today. Its charter as amended in 1872 grants it absolute tax-exempt status, and that can’t be changed without the agreement of the Yale Corporation. The Dartmouth College precedent would suggest that Yale would probably win on that claim in court.

But there's a complication. The history shows that Yale can’t claim its tax-exempt status as an ancient, 18th-century right. The state’s present constitution reaffirms the charter as it stood in 1792; but that charter included the exemption cap.

Yale’s argument thus rests on a kind of "gotcha" theory. The state gave it a tremendous new boon in 1872 that it had never had before, then thought better of it. But it can’t go back to the status quo ante unless Yale agrees, which it presumably never will.

That said, I don’t think Yale’s position is completely unassailable. Modern contract-clause doctrine goes beyond the Dartmouth precedent. After determining that a state has impaired a contract, the Supreme Court now asks whether the impairment is reasonable and necessary to serve an important public purpose.

Merely lowering the state's deficit wouldn’t count. But if the state were to argue that it considers the aggregation of vast, untaxable wealth to impede equality in educational access, that would be another matter. Then the state could buttress its argument with the historical truth that Connecticut has wanted to cap Yale’s exemption for all but 10 years in the last 271.

The law may not pass – but if it does, the debate should be interesting. And we shouldn’t be afraid to question an unlimited exemption.

The same enactment also removed the faculty from tax-exempt status. Bummer.

"No State shall … pass any … Law impairing the Obligation of Contracts."

U.S. Trust Co. v. New Jersey, 431 U.S. 1 (1977)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Feldman is a Bloomberg View columnist. He is a professor of constitutional and international law at Harvard University and was a clerk to U.S. Supreme Court Justice David Souter. His books include “Cool War: The Future of Global Competition” and “Divided by God: America’s Church-State Problem -- and What We Should Do About It.”Read more